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A fine line between legal and illegal tax practices

Do you remember the increase of the number of transactions in December 2004 after selling securities owned by the holders-natural persons for over three years? On 1 January 2005 the new regime entered into force and is still in force today and is not allowing the tax exemption on capital gains from disposal of securities after three years of ownership, but only after 20 years. The result of the novelty was that just before the change of legislation the untaxed profits were cashing out.

Back then, I believe rarely anyone was thinking about the concept of tax planning lately often mentioned by the financial administration and the prosecutor’s office who are increasing the supervision and prosecution in the field of tax evasion in their joint activities. Selling the securities at the end of 2004 was frequent and all the decisions of individuals seemed to be socially acceptable, moral and legitimate. A few years later, the financial administration decided the opposite in its control procedures and adopted the position of individual sales to be illusory, since their sole aim was obtaining a tax advantage, and that the individuals’ intention was to sell their securities before 2005 solely not to pay taxes later on. The cases were handed over to the prosecutor’s office which continues the prosecution.

All sales of the securities in above mentioned period had not been identified as illegal, therefore it is important to ask ourselves what separated the legal and illegal actions, mostly on the assumption that the basic inclination of taxpayers was similar in all cases.

We are facing the similar questions each time the tax regulations change, including the just enacted changes that force some taxpayers into the amortization of goodwill, but at the same time doesn’t allow them to reduce their tax base for calculating corporate income tax for these expenses. The solution may be found in the impairment of goodwill, since the expenses from impairments (as opposed to expenditure depreciation expense) are considered a recognized tax expense. Before the impairment, it would be required to obtain the valuation by a qualified person on the basis of which would be determined, if the value of goodwill actually decreased and the conditions for its impairment are satisfied. The assessment of goodwill must be prepared by a properly qualified person who must pay special attention to the methodology and input data used in the process of evaluation. It should be prepared in a transparent and comprehensible manner, since the tax risk is reduced this way. The higher the quality of the assessment, the lower the risk of tax authorities to question the newly specified value and the amount of declared expenditure.

In the letter of the law, the impairment of goodwill is certainly acceptable, but the question is whether the impairment is needed right at the moment of the tax regulation change. Surely this option can not be a priori denied to the taxpayers on the ground of being coincided exactly with the tax legislation change, but such action may increase the tax risk and is therefore necessary to consider the circumstances of each case prior to the decision made. It is not enough to establish that all conditions are met in line with the law, but it should also be checked if the impairment is recognized in accordance with the purpose of regulations.

From a perspective of taxes, it is important for all effects of taxation to be tied to economic reasons, since – under the tax rules – it is needed much more carefully to assess all the motives and the purpose of each taxpayer being lead to the adoption of business decisions, as is the case in other areas of law. In practice, this means that the tax effects generally have to be reflected as a result of business events and not vice versa, to be reflected as the result of tax effects to be achieved. It is therefore important for the compelling economic reasons to exist for the impairment of goodwill and that the impairment is not aimed at obtaining tax benefits. The latter would be inadmissible from the tax point of view.

To adopt the decision on whether the taxpayer’s impairment of goodwill is legal, it is sometimes not sufficient to fulfil all the legal requirements, but is also necessary to present convincing arguments to the tax authorities. The procedures of tax control are increasingly demanding. Partly on the grounds of being the subject of an increasingly complex transaction that requires a professional and timely cooperation with the tax authorities, partly because the Supreme Court of the Republic of Slovenia has repeatedly adopted the decision that the burden of proof is primarily on the side of the taxpayer. With the changes implemented in the tax procedures, the guarantee of the taxpayers’ rights will be further reduced. It is about the changes that in theory may not seem important, but in practice have a significant impact on the tax assessment of the controlled transactions, therefore it is important to be aware of their consequences.

For quite a few years, the tax inspection processes were ending with a final interview in which the inspector acquainted the taxpayer with the findings that influenced his obligations. After the final interview, the taxpayer often had the opportunity to deliver additional explanations and evidence that could change the tax authorities’ decision. The final interview was later replaced by a written introduction now being cancelled.

You will now be left to the good will of the inspector who is obliged, in consistence with your right to being informed, to be regularly informing you about any findings, but in practice this is not always the case. There are the cases when the taxpayer had not been informed about the irregularities established before the end of the procedure and therefore was not able to provide with the documents and other evidence that might influence the decision. The evidence can be provided only in comments on the record, but are taken into account only if the taxpayer is successful in proving that was not able to provide with the evidence before the end of the process for objective reasons.

Proving the facts as described can be very challenging, therefore it is recommended for the taxpayer to regularly and carefully monitor the inspector‘s work, and ask – also via the email – every day to be informed about the findings which could be relevant for the taxation. The official records will not be made about this, so the question is how the taxpayers can protect their rights in case of irregularities. Will they be forced to record the interviews with the inspectors? I hope the Financial Administration recognizes this problem and one of the more complex cases will not be repeated when the prosecutor in a criminal proceeding proposed the elimination of the tapes because the taxpayer was illegally recording the interviews with the inspector, i.e. the official person.